The Ratings Game: Taco Bell parent Yum Brands makes a questionable move with burger joint purchase, analysts say

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Yum Brands Inc. already had tacos, pizza and chicken in its portfolio. With the acquisition of Habit Restaurants Inc., it now has a burger chain as well.

But Mark Kalinowski of Kalinowski Equity Research questions whether this was the best move for Yum.

The two restaurant companies announced Monday that Yum YUM, -0.32%  had bought Habit HABT, +32.45%  for $14 per share, or about $375 million. Yum expects the transaction to have “minimal” impact on adjusted earnings per share in 2020, to be accretive in 2021 and to increase after that. The deal is expected to close in the second quarter of 2020.

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Habit Burger Grill will continue to be managed by Chief Executive Russell Bendel, reporting to Yum Chief Executive David Gibbs.

The deal is the first acquisition for Yum since it went public in 1997, according to The Wall Street Journal. Habit is a fast-casual chain with about 280 restaurants in the U.S. and China, and “strong potential” for growth internationally, the Journal said.

Habit stock soared 32.5% in Monday trading on the news, en route to the largest one-day percentage gain ever for the company. Yum stock has barely moved on the news.

Kalinowski points out that Yum Brands’ other chains are much bigger than Habit. Together, Yum has more than 49,000 restaurants around the world.

“Yum didn’t have a burger concept,” he said. “Habit continues to grow. Maybe a few years down the road, it will be modestly or meaningfully bigger.”

However, right now, Yum’s other brands are significant for the company’s earnings results.

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“I’m not sure Yum is the right owner,” Kalinowski said. “The challenge for the investor: even if sales double [at Habit], does that impact the stock?”

Kalinowski rates Yum brands stock buy and has no rating on Habit.

FactSet is guiding for earnings of 15 cents per share for Habit in 2020 while the outlook for Yum is $4.15.

Yum Brands has an average hold rating and average target price of $112.38, according to 24 analysts polled by FactSet.

Both Kalinowski and analysts at RBC Capital Markets note the consolidation that’s taking place in the restaurant industry.

“While this acquisition adds a relatively smaller brand to Yum’s portfolio, it does represent Yum’s appetite to grow its platform over the long term not only organically but also via M&A following the completion of its three-year transformation,” RBC said.

“The deal seeks to leverage the strength of Yum’s platform to support brand growth not only domestically, but also internationally, and offer another brand for existing Yum franchisees to grow their own portfolio.”

RBC rates Yum stock sector perform with a $107 price target.

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Yum has focused on a turnaround for Pizza Hut, which has lagged behind Taco Bell and KFC. Yum announced in August that it would close hundreds of Pizza Hut locations in the U.S. in order to focus on shifting the brand to a fast-casual delivery format from dine-in.

“Of course, this transition will undoubtedly lead to some disruption and choppiness in the short term,” said Chief Executive Greg Creed on the third-quarter earnings call on Oct. 30, according to a FactSet transcript.

“The team’s focused on the fundamentals of a modern delivery experience is clearly producing results and a good sign for the future of this business as we migrate more and more to an asset-based position to win in off-premise.”

MKM Partners analysts led by Brett Levy think the timing for this acquisition does make sense for Yum since it is a largely franchised company, even if it doesn’t really matter at the moment from a material standpoint.

However, analysts think Yum’s portfolio was missing a burger chain, the largest segment in the industry.

“What we know is a nearly fully franchised system like Yum has the potential to benefit from adding new units as it represents a critical factor for continued cash flow generation,” MKM said.

MKM rates Yum stock neutral with a $115 fair value estimate.

Yum stock has gained 11% over the past year. Habit stock has rallied 29%. And the S&P 500 index SPX, +0.00%  is up 27.7% for the period.

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